Junk Skew Calling! (HYG,DBC,STT,TROW)
There’s a great deal to discuss on the macro/monetary level, but we’re going to divert our attention today to the other end of the spectrum and examine a few, key technical minutiae before offering you a trade.
So let’s begin with this.
There’s an old adage on Wall Street that states, quite simply, ‘the trend is your friend.’
That’s right. Those who’ve played this game the longest will tell you that it’s all rather simple. In a bull market, money is made by remaining long. In a bear market, by staying short.
But there are numerous corollaries to what appears to be so axiomatic simple, including 1) correctly identifying the trend, both intermediate- and long-term, 2) staying on board through ‘noisy’ periods and short term pullbacks, and 3) knowing when and how to play more substantial reversals.
All of these issues are further predicated on your having a system of indicators in place that allow you to adequately identify all of the above so that you’re not caught off guard. It also means you have a reliable safety net to support you if there’s a SNAFU in your system.
If all those conditions have been fulfilled, then, yes, the trend certainly can be your friend.
So what’s the trend du jour? And how do we determine it?
There are a number of ways of calculating which way things are moving, and here are a few of the basics –
This is only a first step, but you can be fairly certain that if the market has been rising for a year or two, or more, then you’re likely looking at a longer term bull market. But again, this is only a starting point.
Our current bull market has been active for some eight years, and for many this raises doubts as to whether the thing has any wind left whatsoever.
Which brings us to our second measure, MOVING AVERAGES.
A full set of moving averages is best employed to accomplish this particular diagnostic, and it’s always better when a weekly or monthly series is examined rather than a daily, which would issue a great many false signals if relied upon over the long haul.
Let’s have a look at our current bull market with the above two criteria in mind, first to get a look at the existing trend, and second to see which direction we may be headed next.
Below is the S&P 500 for the last ten years, and it clearly shows that, historically, we’ve done very little but go ‘up’.
Eight full years of bullish action says we’re in a bull market.
But has she grown long in the tooth? Are we already at the end? Should we pull the sell trigger yet?
A look at the WEEKLY moving averages sheds light on the subject. And here, too, we find some comfort.
All the weekly moving averages are unfurled and trending higher, a sure sign that we’re in the midst of a bullish trend (red arrow). That condition has been extant for three years now, and though it’s a lagging indicator, we don’t feel there will be a great deal to worry about until, at the very least, the short term (27/28 week) MA crosses below the 137 week MA, a development that last occurred in the early summer of 2008 (blue box at left).
By the way, using that crossover as a sell indicator at the time would have kept an investor safe throughout the terrors of late 2008/09, when the index forfeited better than 55% of its value, peak to trough.
It also would have put you back into play in early 2010, offering a clean ride higher for the next seven years (blue box, right).
We’ll be keeping an eye out for similar crossovers as the market reels and rolls through the year.
So what do we do now?
Back between 2008 and 2010 when the MAs were discombobulated, it was wise to be concerned about market direction, but now that they’re shooting straight, we have to put our trust on the long side.
And a look at the daily chart confirms this –
This is the daily S&P 500 for the last three years, and it also portrays a picture of steadily rising moving averages, all unfurled, with price trending above them all (far right).
There was a period of confusion between the summer of 2015 and the spring of 2016 (red square), during which the MAs began to spaghetti about – and investors would have been wise at the time to be on the lookout for broader indications of weakness. But that condition began to remedy itself by last summer, when all the daily MAs began trending higher.
By the time our current president was elected in November, the daily moving averages were completely unfurled, and investors heeded the call with massive buying (see volume figures).
Today we see little reason to alter our prognosis for equities, and while we study a great many other indicators on a day-to-day basis, the all-important moving average test is unequivocally passed. The bull is our friend.
Trade ‘em and Win!
We’ve got to take action on a couple of trades today, so listen up.
First, our January 17th commodities initiative is in trouble and we have to roll it out. The letter was called Commodity Resurrection and in it we adjured you to purchase the DBC April 16 CALL for $0.65 and sell the DBC April 16 PUT for $0.60. Total debit on the trade was $0.05.
With DBC now at $15.21, we’re urging you to buy back the call for $0.85 and sell the May 16 PUT for $0.80. You tack on another nickel to your initial debit, but save yourself more potentially damaging losses by buying some time.
Get on it.
Next is our March 14th trade from a letter called Where Prices Clash with Belief. There, we recommended you consider selling the STT August 18th 77.50 PUT for $4.20 and buying the TROW October 20th 70 PUT for the same price. Zero sum was the result, and today we have a profit.
The STT PUT trades for $3.65 and the TROW goes for $5.20. Buy back the former and sell the latter for $1.55 on nothing laid out. Adjusted for minimal commissions, and that’s a 933% take – in three weeks!
And Now For One Hum-Dinger!
High yield (junk) bonds area proxy for the stock market, and they take their direction directly off equities.
We like the resilience the iShares iBoxx High Yield Corporate Bond ETF (NYSE:HYG) has shown of late, and we like the way the options are priced.
With HYG currently selling for $87.78 we see a great opportunity in the following pairs trade –- Content protected for Normandy Executive Lounge, Wall Street Elite, Executive Lounge members only]
With kind regards,
Hugh L. O’Haynew